In a December 8 Bloomberg news report – “Who’s the Bear Driving Up the Price of U.S. Stock Options?” – Joseph Ciolli wrote – “For more than a year, dealers in the U.S. equity derivatives market have noted a widening gap in the price of certain options. If you want to buy a put to protect against losses in the Standard & Poor’s 500 Index, often you’ll pay twice as much as you would for a bullish call betting on gains. New research suggests the divergence is a consequence of financial institutions hoarding insurance against declines in stocks.”

CBOE SKEW INDEX

The levels of the CBOE SKEW Index indicate increased demand for out-of-the-money (O-T-M) SPX puts during the past couple of years. The average daily closing levels of the CBOE SKEW Index have been —

(a) 118.0 since its start date in January 1990,
(b) 129.8 in 2014 (the all-time high for any year), and
(c) 126.9 in 2015 (through Dec. 8). VOLATILITY SKEW FOR SPX OPTIONS

The volatility skew charts below show that Bloomberg’s estimates for SPX 30-day implied volatility on recent dates were quite a bit higher for SPX options at 80% and 90% moneyness when compared with SPX options with moneyness at 100 or higher. Reports have indicated that O-T-M SPX put options usually have had higher implied volatilities than at-the-money SPX options and O-T-M SPX call options since 1987.

(1) The skew for the S&P 500 is the highest of any major market in the world, and

(2) The S&P 500 skew may remain high because of regulatory pressure on big banks to hedge big downside risks. Regulatory initiatives include – (a) Comprehensive Capital Analysis Review (CCAR), an annual exercise by the Federal Reserve to assess whether the largest bank holding companies operating in the United States have sufficient capital to continue operations throughout times of economic and financial stress, (b) Dodd-Frank Act stress testing is a forward-looking component conducted by the Federal Reserve and financial companies supervised by the Federal Reserve to help assess whether institutions have sufficient capital to absorb losses and support operations during adverse economic conditions.

DEUTSCHE BANK ON HIGHER SKEW

In his December 8 Bloomberg news report Joseph Ciolli wrote about the possible reasons for the higher S&P 500 skew levels —

“… While various explanations exist including simply nervousness following a six-year bull market, Deutsche Bank AG says in a Dec. 6 research report that the likeliest explanation may be that demand is being created for downside protection among banks that are subject to stress test evaluations by federal regulators. In short, financial institutions are either hoarding puts or leaving places for them in their models should markets turn turbulent. ‘Since so many banking institutions are facing these stress tests, the types of protection that help banks do well in these scenarios obtain extra value,’ said Rocky Fishman, an equity derivatives strategist at Deutsche Bank. ‘The way the marketplace has compensated for that is by driving up S&P skew.’”

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